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Valeant: Revenge of the Fools

This post is about drug companies raising prices, but it will not be about Martin Shkreli and his company. (I’ve decided, by the way, to stop referring to it by name, because it annoys me no end that it’s such a blatant attempt to borrow the name recognition of a great man). No, I’ll just mention that despite his public statements, Shkreli doesn’t seem to have actually announced any new price for Daraprim, so his business model continues to have a lot more in common with an extortion racket than a legitimate drug company.

The rest of this post is going to be about a bigger problem: Valeant. They’ve been taking a lot of fire recently, and they most certainly deserve it. When you look at their pricing behavior (as shown in this Financial Times article), they’re just only a shade less blatant than the Martin Shkrelis of the world, and they work on a much larger scale. I’ll give Shkreli something, though: he pays lip service to the idea of R&D, and (comically) says that his high prices are there to support it. Valeant doesn’t bother with any of that crap. (When they do start talking about internal research, they’re mostly wrong). No, the company’s position has been clear for years now: R&D is for losers and fools. I mean, you can lose money doing that stuff, and why would you ever put yourself in a position to lose money? Better to let someone else de-risk everything first, buy them, and then ramp up the prices, right?

It will surprise no one that Michael Pearson, the company’s CEO, is a former McKinsey consultant who hit on this business plan during his time looking over the industry from outside. (In the same way, Martin Shkreli had his insight while investing – unsuccessfully, it has to be noted – in biopharma companies while running his own hedge fund). In both these cases, we have people who are approaching the whole business as an exercise in financial engineering. In the same way, a Wall Street type like Bill Ackman can defend the company by saying that the money they’ve paid to buy out other research organizations is, you know, pretty much the same as spending it on research itself, right? So Valeant is actually one of the biggest R&D spenders out there, right? (That last link will explain more about how defective that line of reasoning is, although it may be apparent already, and if you’ve guessed that Ackman is a large investor in Valeant, your radar is calibrated correctly). My own take on Ackman’s idea has already been said by Orwell, that one would have to be part of the intelligentsia to believe something like that, because no ordinary person could be such a fool.

The whole “it’s-money-that-matters” approach (as I’ve mentioned before) is exactly what most critics of the drug industry accuse every company of doing (“You don’t care about patients! All you care about is your quarterly earnings, you heartless pirates!”) But here are the people living the stereotype, and proudly. Doesn’t matter that this strategy brings the whole industry into even worse repute than ever, which is quite an accomplishment. That’s not Valeant’s problem. Doesn’t matter that it’s a parasitic business model that can only work as long as not too many other companies decide to follow it: that’s not Valeant’s problem, either. Doesn’t matter that it infuriates patients and insurance companies either, as long as they keep reaching into their pockets while they’re shouting and hopping around. Should we double the prices of our drugs this year? Why the hell not?

. . .Valeant’s practices stand out among the larger pharma and biotech companies.

So far this year, it has raised the sticker price of 56 drugs or about 81 per cent of its portfolio, according to analysts at Deutsche Bank. The average price increase was roughly 66 per cent while the steepest, for the gastrointestinal drug Zegerid, was 550 per cent.

By comparison, US group Pfizer has increased the price of 51 of its drugs so far this year, equivalent to roughly 71 per cent of its portfolio; the average rise was roughly 9 per cent while the sharpest was 15 per cent.

The only bright spot I can see in all this is that (as the FT article says) the company has had to take on substantial debt to acquire all these drugs, which means that their strategy is predicated on being able to get away with such price increases for an extended period. And they’re already cut expenses back about as far as they can go, presumably: the company spends 3% of revenue on R&D, as compared to a big-pharma average of about 15%. (And if you want to talk about marketing spend versus that, see here). Pearson himself is telling investors, and everyone else who will listen, that Valeant, while it just might have conceivably based some of its business on price rises at some point in the past, will henceforth earn bushels of money by increasing sales volume instead. No one can get upset about that, can they? But since the company doesn’t say very much about sales volume to start with, analysts are having a hard time getting behind that idea. And the company’s debt load can only make sense in an environment of near-zero interest rates, but one hears persistent rumors that these may not obtain forever.

So we’ll see how Valeant holds up. There’s a well-known reward for those who live by the sword, and I’d be lying if said that I’m not looking forward to watching them claim it.

35 comments on “Valeant: Revenge of the Fools”

  1. All I can say (write) is, “Here, here!” Or something otherwise yelled in Parliamentary-like approval. I wish I’d written this.

    It appears that Martin Shkreli actually attempted to copy the business model of Valeant–ie, buying up the marketing rights of old drugs, creating virtual monopolies by gaming the FDA regulatory system, and then jacking up drug costs. It’s just that Shkreli did it much more brazenly with a few drugs (first at Retrophin and now Turing), while Valeant was relatively more insidious and stealthy in its actions, but with a much bigger chunk of the market. That is, until Shkreli threw a spotlight on the entire murky practice of drug pricing.

    While Valeant could not care less about R&D (why even bother with a 3% investment?), Shkreli would now like to claim, in retrospect, that most of the Daraprim revenue will go toward R&D for a newer, better Daraprim and other drugs for rare diseases. The problem with that promise is 1) it comes from a former hedge-fund manager with a history of highly questionable dealings; and 2) it puts the revenue cart before the R&D horse–thereby placing the burden of Turing’s R&D funding on the backs of patients, insurance companies, and Medicaid/Medicare (meaning, the rest of us). It’s simply just not right. It wasn’t right when we first heard of the Daraprim price hike 3 weeks ago, and it’s not right now.

  2. biotechtoreador says:

    Maybe drug companies should renounce profits and continue as charities serving the public weal? Pharma employees working for free in labs funded by charity, would certainly be altruistic. My guess is that that system would not bring too many drugs to market, but I may be wrong. Until the above happens, though, biopharma will continue to be all about the money, just like every other business.

    1. @biotechreader
      You craft a nice straw man. No one here will propose that pharma companies be run like charities. If you run them like pirates though, you shouldn’t be surprised if people start treating you like one. Buying up drugs that have had their associated R&D costs recouped many years back and then jacking up the price is going to encourage people to call for your head. It will also make the rest of the industry look bad and increase calls for regulation. It’s the ultimate short term racket- they’ll make money now and 10 years hence when the howls grow too loud to ignore they won’t be around to get nailed by price regulation.

  3. biotechtoreador says:

    “placing the burden of Turing’s R&D funding on the backs of patients, insurance companies, and Medicaid/Medicare (meaning, the rest of us).”

    Who do you think currently pays for pharma R&D?

  4. sm says:

    Let’s not forget that people who buy these stocks are to blame too. People are greedy. I have no sympathy for any of these companies and their followers.

  5. John Wayne says:

    SM, that is a fascinating line of thought. Does being a shareholder of a company make you somewhat responsible for their behavior? Most of us would agree that it does, at least a little. If the shareholders are 0% responsible for the ethics of a company, that does put the system in a situation wherein there will always be some terrible things going on.

    What law firm is going to step up and (for example) sue the shareholders of Volkswagon for putting profits above the environment?

  6. Luigi Facotti says:

    Is Shkreli any different in intent from from David Blech or Sam Waksal?
    BTW Pathophilia – “hear, hear” is the actual term.

    1. @Luigi Facotti
      Thanks for the correction. Or “Hear, hear!”

      @biotechtoreador
      In a startup, the usual model is that initial R&D funding is provided by upfront VC investment.

  7. anon says:

    @ John Wayne

    So, you think people have no responsibility even if they do see their actions? Would you support someone who hurts others? It’s pretty much the same. But, when money is involved, people choose to forget about ethics.

  8. Joe Q. says:

    There are not a lot of Canadian-based bio-pharma companies, and it kind of embarrasses me (as a Canadian) that Valeant is one of them.

  9. A Nonny Mouse says:

    We used to have a charitable drugs company called Wellcome until the Trust, too, got greedy (justified by “……not have all the eggs in one basket, no matter how good that basket may be.”) and sold out to Glaxo [although I am told that Pfizer made the original move].

    Maybe they were right as they seem to have prospered better than the pharma companies by investing their lucre in shares and properties (including very dodgy payday lenders!).

  10. I’m wondering what kind of market Valeant’s drugs actually have.

    Sure, they raised the price of Zegerid by 550%, but it’s nothing more than omeprazole (available OTC) and sodium bicarbonate. Who on earth would actually pay ~$100 per capsule for that?

    If I were a doctor or patient, I’d just have them take omeprazole from Costco and save the medical system 98% of the cost.

    And what kind of an insurer would actually reimburse for that drug?

    Apparently Zegerid has an OTC version that is ~$0.50 per capsule. That’s 0.5% of the cost of prescription version. It still has 20 mg of omeprazole, but a little less sodium bicarbonate.

    I guess my question is, who cares if a drug company cranks up the price of a drug where there are multiple alternatives?

    1. Thomas says:

      The high price shows something strange is going on: the buyer is not the one who is paying. That this happens proves that the market does not work in all cases.

      Nobody would pay $100 for a liter of gas. Except if someone else paid.

  11. biotechtoreador says:

    “In a startup, the usual model is that initial R&D funding is provided by upfront VC investment.”

    Yes, and VC investment is provided from profits from revenue from drugs….Also, just because that’s the ‘usual’ way doesn’t mean its the best way. Pharma pays for its R&D from drug revenue, which is what Turing is planning to do. How is this different? Should GILD not be able to use Solvadi revenue to pay for R&D because hey didn’t invent it?

  12. Nick K says:

    I’m sure Derek has explained it somewhere, so forgive me for being obtuse here, but what is preventing competitors from undercutting Turing and Valeant on these out-of-patent drugs?

  13. John Wayne says:

    @anon

    I’m not aware of an example of the investors of a company being held responsible for it’s behavior. Until that changes, investment decisions will be based on a person’s individual ethics. As a society, we need to decide if we’re comfortable with that.

  14. Richard W says:

    I am not a shareholder of VRX. I simply see its way as a different approach of starting, developing and growing a drug company. Putting aside the emotional/ethical judgments for the moment, VRX approach is rational and logical. It sees undervalued assets in other companies and buys them. Isn’t this what other investors do? Buffet, Peltz, and Icahn do it. R&D is difficult, expensive and very unrewarding. The drug now known as Tagament was the best selling drug in the 1970’s. The millions of dollars of R&D it financed for Smithkline produced nothing that could move the needle for it. The same can be said for PFE Lipitor. The big companies know R&D is high risk. Remember the mega merger mania when all the large cap drug companies gobbled each other? Here’s a memory prompt: Wyeth, Upjohn, Schering-Plough, Genentech, to name a few, all gone. Large pharma bought these companies for their approved drugs because these drugs were meaningful (move the needle) for the acquirer. This is not unlike oil companies drilling for oil on Wall Street during certain times.

    When you start a company like VRX, the sales can not support 15% of sales R&D. So they buy other drugs which, with all due respect, is equivalent to spending on R&D, IMO. I miss your point that it is not (i would love it if you can explain it again). Yes, VRX will not be able to continue this forever since like the large drug companies, it will find it difficult to find something to move the needle. Then they will have to transition to R&D. Remember Forest Labs? I believe VRX is following its footsteps. Forest used to buy unwanted drugs from the big boys, but once it got too big it had to start its own R&D. By the way, Actavis bought out Forest last year.

    Buyouts will continue as internal R&D of big pharma will not be up to the task. Another perspective: all well financed labs have an equal chance of coming up with a multi-billion pharmaceutical. The number of well financed biotech startups vastly outnumber the drug/biotech companies whose market cap > $20 billion. Biotech buyouts will continue. Remember Gilead buying Pharmasett for its nuc? And with this correction, VRX since the start of 2009 has return 50% compounded annualized growth rate for its shareholders. PFE returned a very respectable 18.9% CAGR.

  15. a says:

    There is only one solution : nationalized pharmaceutical industry

  16. Vader says:

    @John Wayne: When you sue or fine a company, you’re suing or fining its shareholders, pretty much in proportion to their say in how the company is run. No?

  17. anon says:

    Given how little say shareholders actually have in the running of an American corporation vs. management (see the debate about CEO compensation), it would be unfair to hold shareholders responsible beyond any loss in share value.

  18. anon the II says:

    Valeant, Turing, Pfizer.

    I’m sorry, all I see is a difference in degree, not in kind. Pfizer has destroyed substantially more research than Valeant could ever hope to not fund. Thank goodness, I’m no longer part of this greedy industry.

  19. matt says:

    @biotechtoreader, I get that you’re trolling, playing the devil’s advocate, because you really don’t care. But you are making precisely the error Derek called out in the piece, the stupid argument only an intelligent person could believe, because of the level of rationalization and hand-waving involved.

    Tell you what, you give me $50k, and when it clears the bank, I will look around and see if I can’t find you a vehicle to drive. Only a fool would take that deal, and that’s the deal Shkreli is offering. But isn’t that the same business model a car dealership uses? No. It is similar except for one key piece, the timing of payments for value.

    But all of this handwaving about Shkreli is pointless. Change the rules, and change the way the FDA regulates manufacturing processes as necessary so Shkreli can’t get a monopoly on a generic, which as far as I can tell is what he’s doing, and the market will take care of the rest.

    Valeant, because they are buying companies/medicines which have “legitimate” market exclusivity, is much harder. They may get tolerated, in the way shady companies that pay a lump sum to lottery winners and court settlement winners are tolerated, or pay day loan companies are tolerated within limits.

    Perhaps the market exclusivity benefit gets tagged with a requirement the seller is required to reinvest a certain percentage of the gross back into R&D for new drugs. The government giveth monopoly power to make ungodly profits, the government taketh away some of the freedom to do whatever you want with the money. Or perhaps Medicaid/Medicare tag such companies without an R&D arm as profiteers, and simply refuse to pay any more beyond what it considers reasonable. With the reasonable value lowered appropriately toward generic prices by the understanding the profit is not supporting any future drug development. If Medicaid/Medicare took such a step, I would guess private insurers would do the same very quickly.

    Regarding the mess about Johnson & Johnson’s off-label marketing of risperidone (, I think the FDA should have the power to strip six months off market exclusivity for violations of off-label marketing. And, when the company drags its feet, or successfully hides evidence that it has acted illegally until after exclusivity has run out, then the _mandatory_ fine is equal to the revenue gained from that product during the last six months of sales. Yes, it should be nearly ruinous. And, also mandatory, the government “claws back” two years’ salary of the chairman of the board, chief executive, chief marketing/sales officer, and chief financial officer, and they are barred from holding a senior management team or board of trustees position at any company for which the FDA is reviewing drug applications.

    Coupled with that, though, the government needs to stand up a website for off-label clinical research, perhaps a combination of clinicaltrials.gov and NIH-ish or AMA-recognized research articles. If companies genuinely want to provide doctors information about the performance of a drug in a particular off-label application, this site would provide the peer-vetted, FDA-qualified data that companies would be allowed to point towards. Trials must be registered prospectively. And the nearly raw data from the trials, accounting for every participant, edited only to preserve patient privacy, must be posted for every research article which cites clinical trial results. Just as it is now, the off-label research can be sponsored by the drug companies, or done by private organizations.

    Just my spitball ideas.

  20. DCRogers says:

    “The only bright spot I can see in all this is that (as the FT article says) the company has had to take on substantial debt to acquire all these drugs, ”

    Helps protect them from being a LBO (leveraged buyout) target.

    And what’s not to love about taking money off the table (and into people’s pay and bonus packets) in exchange for IOUs? If and when the business model collapses, that leaves the bag-holders far removed from the pockets with the cash.

    The idea that there is any opprobrium associated with debt, moral or practical, is old school.

  21. Andy II says:

    This posted story reminds me of my old company. We were developing drugs (R&D company). When one of the product got near the approval, we decided to have a commercial devision and hired a new CEO from a big pharma with significant experiences in marketing. He also brought in a group of young MBAs from that consulting firm. He revised our old pricing idea to be 5 times and completely eliminated R&D division (no more discovery thru NDA, except clinical and manufacturing) after careful evaluation of cost analysis of internal discovery/development by these MBAs.

  22. Erebus says:

    @a:

    A nationalized pharmaceutical industry might be the only thing worse than what we currently have. As things stand, what we need is more room for competition where generic drugs are concerned — and far less regulation in general. The regulations we’ve got are already onerous, unusual, are obviously open to abuse, and are capriciously enforced.

    Needless to say, that Shkreli can purchase a ready-made monopoly is a travesty, and it highlights how broken the regulatory system is. If other companies were able to compete on price, I am convinced that Daraprim would quickly return to its old level at $15/capsule or less.

  23. F says:

    Shkreli gets away with it because of the regulatory environment. Reg environments with perverse consequences are not unique to pharma – they are the reason I left my old profession. (Having to ship AAA batteries from Belgium to Shanghai then to Frankfurt in the name of compliance with EU labeling laws “intended to protect the environment” was the last straw.)

  24. bank says:

    @A Nonny Mouse

    Wellcome now provides enormous amounts of funding for basic research in the UK and world-wide. That the original company was sold in order that the Trust could diversify its income stream seems to me to have been a good move, otherwise it could well have ended-up as many Pharma companies do. Absorbed, traded, “restructured”, etc, it may well have ended up losing the majority of its assets.

  25. enl says:

    @Nick K: the things preventing competition include: start up cost for manufacture (physical plant and approvals), which are already done in the existing situation, and a perversity of the regulation that gives exclusivity to whoever files additional paperwork on drugs approved under older approval processes.

    The players in this game have a monopoly in the Sherman Anti-trust sense, without the regulation required for a utility. Unlike, say, blue jeans, the customers can’t forgo the product, at least without major consequences including death, and they can’t switch to an equivalent product, such as khaki’s, as there is no equivalent product.

    Due to the laws on the financial side, the stockholders of these companies can sue if the management does NOT maximize profit. At this point, the management in question may not be able to lower the price without being removed. Even a minority stockholder can bring suit. Of course , suing because the management is immoral and criminal isnt really possible for a minority stockholder (unless they are willing and able to bankrupt the company in the process) unless there have been regulatory or criminal findings already.

  26. Andy II says:

    And here is another article with a rather sensational title published in Fierce Pharma though someone may have already talked about.
    Big Pharma teams up to defeat drug pricing proposal in California
    http://www.fiercepharma.com/story/big-pharma-teams-defeat-drug-pricing-proposal-california/2015-10-08?utm_medium=nl&utm_source=internal

    Wondering if they are absolutely insensitive to the public opinion…

  27. Old Timer says:

    The “3%” on R&D is due solely to their unwinding of R&D of previous acquisitions! It’s hilarious people think they’re actually doing any!

  28. John Hempton says:

    If buying a company is R&D spending then it should be an expense in the profit and loss statement.

    After all R&D spending is largely an expense.

    Lets take the idea that it is spending seriously. [I am a finance type – I am happy to do so.]

    In that case all the money that Valeant has spent on acquisitions should be expensed from the accounts.

    They have 30 billion debt from this expense.

    Valeant is – on this measure – perhaps the biggest loss making listed company in the world.

    John

  29. milkshaken says:

    Maybe Shkreli can christen his next company Göring Pharmaceuticals. You can’t beat that name recognition – not even with a rubber truncheon.

  30. Noacrook Wheniseeone says:

    In response to earlier posts “And what kind of an insurer would actually reimburse for that drug?” and “The high price shows something strange is going on”
    Bingo!
    He who holds the insurance premium $’s controls everything.
    Healthcare insurance companies are among the largest cap for-profit publicly-traded entities on earth. More than 90% of outpatient and inpatient Rx drug doses administered in the US are “generic”. Generic drug cash prices have skyrocketed to prevent covered lives (us) from selecting less expensive high-deductible insurance plans that allow us to pay low cash prices for generics. Whether it is a long-time generic oncolytic agent like methotrexate or ancient anti-hypertensives or CNS medications,..all the generic cash prices have skyrocketed. Insurance companies want you paying high premiums so you pay a $2.75 copay instead of $275 cash price. The profit to the insurance companies is in the “premiums” we pay them and in the contract performance “rebates” paid by the drug manufacturers to the insurance companies, specialty pharmacies, GPO’s and distributors. None of these crooks in the middle can survive and grow on their % vig if the stated WAC prices go down. X% of X% of more is more. Everybody wants more of our money, and it all starts with “he who holds or insurance premium $’s”. Valeant is far from alone in it’s criminally creative engineering of its income statements and balance sheets,..but it is certainly a glaring at example of immoral greed.

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